Sergey Shirko has been studying the forex market for about ten years, and has been working in the FX industry since 2009. He has worked at a number of companies, including TeleTrade and Soft-FX. He has been the Chief Dealer of FXOpen since December 2012.
Before my enthusiasm ran out, I decided to continue the theme that I began in the previous article. Moreover, judging by the comments and feedback that I have received, the interest in this subject is obvious.
Don’t expect that after reading this material you’ll be able to start working with reports, which I have already mentioned. My job is to give you a general idea, and if it takes root in your mind you will be to develop, without my help, learning materials by other authors, and there are many. Ideas that will be outlined below are not my insight. I just picked those options that I myself find more appropriate. I suggest you do the same — to evaluate and choose.
Commitments of Traders (COT)
The first report is COT. Every week the US Commission Commodity Futures Trading (CFTC) publishes data on purchases and sales made during the previous week by three groups of traders: hedgers (or operators ), large traders (large speculators) and small traders (small speculators). In the COT report operators will be specified as Commercial, large speculators — Non-Commercial and small speculators — Nonreportable Position.
For a better understanding of participants in each group relative to the currency market I refer to operators as banks, large speculators as various funds involved in money management, and small speculators such as you and me.
My attention is drawn to only one group of the three: operators. For analysis I use their total net position:
12 042 Long — Short 46 274 = – 34 232 Net Position
In our example the operators have a net short position of 34 232 contracts. I compare this result to historical values over the past three years. When this value approaches the historical values, I expect a market reversal in the direction of the net open position of the operators and I look for a confirmation on the price chart, but not before this condition is met.
Meaning that if the operators have a maximum three year net short position, I expect the market fall, and vice versa. I expect a rally if the operators have a maximum net long position over three years.
I am convinced that this group has the greatest influence on the price and, more than others, is aware of the future value of the product. This is confirmed by historical data.
The chart shows the daily price of the futures on the Australian dollar on the top and the net position of operators at the bottom. Here we can see that the market often reversed in those moments when the operators has historically maximal net open position. Long position – and the market grew up, short – and it fell.
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As for the COT report, I would stop here and move on to the next report. However, please keep in mind that this is just the basic idea, and there is still something to think about and to discuss.
Daily Bulletin (DB)
Every day after market closing the Chicago Mercantile Exchange (CME) generates a separate report for each instrument. In cases where the data is not much, the exchange combines the assets. This report contains a lot of information on futures and options among which we can find the data on the volume for the previous day, open interest (open positions) at the end of the day, and so on.
Our main interest in these reports is open interest by the end of the day on options on futures. It’s time to say a few words about what an option is and what types of options there are. An option is a contract between two parties for the supply of goods at a particular price at any time until a certain date.
For example, we agree that prior to the first day of the following month, if you have such a need, I’ll be obliged to buy from you 2 million EUR for USD at the exchange rate of 1.09, even in the case if the euro will cost less, say 1.03. For this opportunity you pay me a premium and if you didn’t take it, the premium will still stay with me.
In this example you wanted to insure against the reduction of the euro against the dollar and you bought a put option, and I sold it. If the rate falls, you will execute your option, and I will get a loss minus the premium that you have paid me when you have bought the option. If the rate becomes higher than 1.09, the premium will stay with me, and you won’t need to implement this put option. The image below shows the report on put options during the current option month.
As we can see, there’re many people who want to hedge from the reduction of the euro against the dollar — 7389 contracts, and the 1.09 level arouses the greatest interest among the participants.
We will see the similar tendency on the back of the market with the call options of the people who want to hedge from the increase in the value of the euro.
However, in this example we see that open interest on strikes is not as concentrated as in the first case. Nonetheless, here we also allocated the strike with the greatest interest. In our case it is 1.12 with 3825 contracts.
Thus, we can see two levels, one of which is located below the current price, and the second above it: 1.09 and 1.12 respectively. If during this option month the price rises above the 1.12 I will look for sales, if it drops below 1.09 I’ll look for purchase, but not before this condition is met.
Here I am convinced that the group of participants who sell options for everyone who wants to hedge from rising or falling prices would not be doing this if they were not sure that the price by the end of the option month doesn’t float the price corridor of between 1.09 and 1.12. Only in this case the sellers of the options will be able to retain the received premiums for both the put and the call options.
Unfortunately, I don’t have a beautiful picture with historical data confirming my words, as in the first example. You’ll have to take my word for it or to investigate the matter.
Of course everything is not as simple and definite as it may seem at first glance, and I would ask you not to be blinded by the ideas that I have outlined here. I’d even tell you that I’m not quite sure that my methods of analysis give a greater percentage of positive trades than any other. However, they more than others reflect with my own belief system and seem to be less of a phantom than anything else.